Discounting the V-bound
Global developments trumped domestic dynamics during November, leaving SA asset markets stronger. SOSO (stimulus on/stimulus off) and VOVO (vaccine on/vaccine off) aligned for the perfect financial market backdrop.
The US election was resolved quickly in the context of elevated fears of drawn out contestations. Moreover, it resulted in a divided congress, as the Republicans maintained control of the Senate, and a victory for Joe Biden. While this reduced the prospect of a massive fiscal stimulus package, it eliminated the risk of substantial tax rate hikes. As we know, equity markets dislike uncertainty and tax hikes. A smaller fiscal package would mean less government borrowing than originally feared, which should limit some of the upside to US bond yields. However, less fiscal support will put a greater burden on the Fed to keep policy accommodative. This combination, as well as ongoing positive news on the vaccine front, should be bearish for the US dollar and positive for EM assets.
Pfizer/BioNTech, Moderna, and Oxford/AstraZeneca reported high efficacy rates from their phase 3 Covid-19 vaccine trials. This sparked hopes that global activity would normalise quicker than originally estimated, as the various vaccines would be rolled out to the bulk of DM by the middle of 2021. A faster return to normal poses upside risk to 2021 global growth forecasts, but some of this may already be reflected in asset prices. Moreover, the cold-chain logistics of distributing the vaccines could be challenging for emerging markets. South Africa has not yet secured access to any of the vaccines, which would delay any rollout locally and so too the normalisation of activity and mobility.
Beyond the second wave of Covid-19 infections locally, SA investors are facing additional concerns. The SARB is seemingly reluctant to ease monetary policy further, with the MPC keeping the repo rate unchanged at 3.5% at the November meeting. The close vote (3:2 in favour of a hold) suggests that there is ongoing disagreement about the need to give the economy additional support versus the risk to the rand and inflation from the worsening fiscal position. While we think there is upside risk to FY21 revenues, we do not dismiss the meaningful execution risks associated with the planned consolidation. The multi-year nominal wage freeze will be challenging, particularly if inflation rises too far too fast. On this score, the upside surprise in the October CPI prompted the FRA market to price out further rate cuts and to bring forward the timing of the first hike to 3Q21. Notably, food prices accounted for the bulk of the overshoot in inflation, with this component making up a relatively larger share of middle and low-income groups’ spending. The higher the inflation rate on basic goods, the more difficult it will be to follow through on wage bill reform.
The Financial Stability Review emphasised the multi-channel risks posed by the rapid rise in the government debt burden and debt service costs. This year, almost 60% of government revenues will go towards wages, and a further 20% will go toward debt service. As foreign investors have reduced their appetite for SA debt, local banks have stepped in. This has partly been driven by regulatory requirements associated with rising deposits, which in turn reflects demand for precautionary (and liquid) savings amid elevated uncertainty and economic strain. The bottom line is that the sovereign and banks are now joined at the hip. The loss of the investment grade credit rating from Moody’s was “the event” to watch due to the capital outflow consequence, but investors should not ignore the risk of further rating downgrades. To be sure, while S&P affirmed the credit rating at BB-/stable outlook, the recent downgrades by Moody’s (from Ba1/negative outlook to Ba2/negative outlook) and Fitch (from BB/negative outlook to BB-/negative outlook) came as a negative surprise. Market access becomes a larger constraint the further down the rating scale a sovereign moves, with borrowing costs and default risk commensurately higher.
The positive news in November was the steady progress at the Zondo Commission, with ex-president Zuma making a brief appearance, as well as the NPA charging ANC Secretary General Magashule with fraud and corruption. While strong action against corruption will help lift business and consumer confidence, the wheels of justice turn slowly. So too, it would seem, does the implementation of reform.
Markets received a shot in the arm in November as listed property (17.5%) surged, beating all the other asset classes. Equities (10.5%) posted a solid performance, followed by bonds (3.3%), ILBs (2.0%), and cash (0.3%). The stronger rand (5.2% versus the US dollar) would have diluted gains in offshore equity and commodity allocations.
The US dollar index lost 3.5%, with DM risk currencies, such as the Norwegian krone, New Zealand dollar, and Australian dollar benefiting the most. The combination of dollar weakness, stronger industrial commodity prices, and improving risk appetite supported EM FX. The Colombian peso (7.5%) and Brazilian real (7.2%) were notable outperformers. Rand gains (5.2%) were also driven by another solid trade surplus and a resumption of foreign portfolio inflows. According to official statistics, non-resident investors acquired R30.7bn nominal equivalent of government bonds during the month. The November rally has pushed the rand into modestly overvalued territory based on our 15.50 – 16.50 broad fair-value range for USD/ZAR.
The US 10-year yield oscillated around 0.86% with a modest upward bias, while the slight decline in the TIPS yield widened breakeven inflation to a 12-month high of 1.8%. Less aggressive fiscal stimulus dampened the ascent in the global risk-free rate, but a more rapid normalisation in activity during 2021 should put some upward pressure on US yields. EM external debt gained 3.9% and local markets jumped by 5.7% amid a wide-ranging underlying performance – Lebanese yields rose by 130bp, in contrast to the 50bp decline in Mexican rates. SA was a relative outperformer with the 10-year yield falling by 33bp. At 9.00%, the valuation on the 10-year is neutral, once accounting for elevated fiscal risks and compared to the peer group’s tactical performance. Gains across global equity markets were robust and broad-based, with the risk-on backdrop benefiting most markets over the US and China. The MSCI World Index rose by 12.8% (total return), outperforming the 9.2% gain in the MSCI EM Index. Yet the underlying performance was skewed towards double-digit returns from most markets, with Poland taking pole position at +28%, while China’s 3% gain was a drag on performance. The ALSI gained 10.5% and SWIX rose by 8.3%. Local gains were also broad-based as global growth expectations boosted the local market and most rand hedges, in addition to the benefit to SA Inc. from improved local mobility. Consumer goods (21.9%), industrials (20.5%), financials (17.1%), and basic materials (10.9%) posted double digit returns, followed by consumer services (9.7%), telecommunications (9.4%), and health care (4.8%), with technology the laggard (-0.2%). The lower gold price and rotation out of pandemic defensive areas dampened returns from the gold mining (-17.5%) and media (-2.9%) sub-sectors.